Insurance 2024 outlook

Regulatory Outlook 2024
Solvency II reform to continue throughout 2024

Following a year in which disagreements surfaced between Government ministers and the Prudential Regulation Authority over the extent of reforms to UK Solvency II, 2024 should be the year in which the final technical details of the reform package are ironed out and brought into force.

A three-phase approach to completion

The UK authorities plan to finalise the reform package in three tranches:

Tranche one: HM Treasury will legislate to reduce the Risk Margin.  Draft regulations published¹ in June 2023 proposed to cut the risk margin for long-term life insurance by approximately 65%, and for non-life insurance by approximately 30%.  The final legislation is expected by the beginning of 2024.

Tranche two: the PRA will publish final rules on the Matching Adjustment (MA).  In September 2023, the PRA published a consultation paper setting out draft plans to “enable broader and quicker investment by insurers in their MA portfolios”², as well as an attestation process for the amount of MA benefit being claimed. The PRA expects to publish final policy and rules on the MA during Q2 2024, with the changes coming into force on 30 June 2024.

Tranche three: all other Solvency II reforms on which the PRA has consulted will take effect on 31 December 2024.  These include the draft proposals consulted on in June 2023, which the PRA predicts “will allow a meaningful reduction to the existing administrative and reporting requirements for the UK insurance sector”³.

Political pressure to deliver the benefits of reform

Once the reforms are in force, pressure is likely to build on the insurance industry to demonstrate that the benefits – which the City Minister has predicted could be up to £100bn of capital freed-up for investment – are delivered.⁴ MPs have already questioned the PRA on whether its remit extends to monitoring whether capital released under the reforms is invested in the UK economy rather than transferred to shareholders via higher dividends.⁵  Given the constrained state of the public finances, the next government (of whichever colour) is likely to look to the private sector – and to the insurance sector in particular – as a source of significant new investment capital.

Macro: flatlining economy, falling inflation

The UK registered zero growth in Q3, and few expect much, if any, for 2024 overall. Inflation remains uncomfortably high and has been slower to recede than in the US and Eurozone. Although the inflation outlook remains uncertain, recent data have shown a moderating trend and the labour market is showing signs of loosening, which should feed into slower wage growth going forward. 

Rates: levelling off

The BoE decision to pause at its September meeting suggests that the bar for near-term rate hikes is relatively high. We think short-term rates should remain capped in the context of relatively weak macro fundamentals and tighter financial conditions. Market pricing suggests that the Bank Rate will stay around its current level throughout most of 2024. However, heavy supply and the lack of liability-driven investment demand continues to put upward pressure on longer-dated yields.

Credit fundamentals: holding up

The cycle is relatively advanced in the UK and Europe with credit events picking up among weaker rating categories. We expect these to continue rising in 2024 given more challenging refinancing conditions. We have seen an uptick in disappointments during the Q3 2023 earnings season, but we still view these as idiosyncratic rather than systemic.

Overall fundamentals are still reasonable, however. Leverage in sterling investment grade is low by historical standards and earnings margins are still elevated. Interest coverage has come down with rising yields and we are expecting it to continue deteriorating gradually, but this is not an immediate concern given well-spread maturity profiles. 

In the US, the credit cycle shows signs of maturing. Leverage has trended higher while margins, interest coverage, and revenue growth have fallen. We expect that corporates will prioritize debt paydowns to control borrowing expenses and defend balance sheets. Downgrade activity escalated in 2023, albeit from a low base, and upgrades still outweigh downgrades.

Valuations: moderate to good

We think spreads on investment grade look reasonable given the macro environment and corporate fundamentals. While the growth outlook is anaemic, Sterling issues are trading substantially outside of their long-term medians. Looking overseas, Euro corporates are also wide of their longer-term averages while US ones are slightly inside – likely due to the stronger growth dynamics in the US. 

As always, the spread levels for an overall index conceal wide variations therein – and there are many relative value opportunities for investors who can pick and choose securities with a global viewpoint.

Insurance Asset Allocation

In the current risk-averse environment, insurers are naturally over-allocating to high quality bonds which exhibit much better spread than during the last decade and which could withstand a potential recession. The relative attractiveness of private debt is decreasing since highly rated credit assets are scarce on the private side, they need to be manufactured which induces a complexity cost.

Amongst the other factors of the asset allocation change of annuities writers, we can quote the increasing need of matching adjustment assets following the fall in the equity release production as a response to the increased interest rates resulting from the mini budget and the increasing activity on the BPA side.

• In Q3 2023 Equity release Market remains suppressed at 2017 levels with new customers down (45%) and total lending down (58%) on an annual basis (Source: Equity Release council Q3 2023)
• UK annuities writers are looking for a substitute to this asset class which is a fundamental building block of their matching adjustment portfolios. An attractive and deep source of long duration could be found in the US municipal bonds market.

On the other sides of the insurance business, private assets perfectly played their role of shock absorbers over the last few years but their relative importance in the balance sheet increased and neared the liquidity risk limits. Though the denominator effect slowed down the allocation to private assets over the last 18 months. 

We expect a repricing of the private assets at year-end and a stabilization of the liabilities’ cost which will leave more room for diversification in 2024. 

Public markets, Fixed income remains the story of the year. 

• CMAs for most FI asset classes are significantly higher than historical returns. Some higher yielding credit assets are expected to outperform even the riskier parts of the equity market (Loans > EM) at much lower levels of risk. 
• Global equities are still expected to return near 6%, however the relative expected outperformance continues to shrink, especially when adjusting for risk and cost of capital. If the current level of volatility subsists, equity risk hedging programs could be an efficient way to reduce the cost of capital and maintain the equity allocation over time.
• On the capital management side, geopolitical events can impact volatilities of all assets, asset classes, sectors and countries. The introduction of a larger share of commodities or precious metals could reduce the volatility of the asset allocation and stabilise the eligible own funds considering our CMA are quite constructive for the asset class in the long run.

On the private markets side, we over allocate to debt over equity to cushion the volatility and refinancing risk and benefit from opportunities which are a good fit for insurers’ risk appetite & ALM: low LTVs and strong covenants.

The focus on diversification and the increasing appetite for inflation linked assets will probably attract new investors in the real estate debt space since higher interest rates and lower inflation have resulted in an attractive entry point thanks to repricing. Besides reduced bank lending creates a compelling opportunity for alternative real estate lenders.

Private Credit quality has also improved since 2022 via lender-friendly documentations and lower leverage profiles notably on the middle market side. Considering loans offer some of the best yields in fixed income despite their senior secured status, we believe their low correlation with traditional asset classes of the insurance balance sheet make them an attractive way to reinforce asset allocation in 2024.